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Business tax changes and planning The good news: Many breaks - and break enhancements - for businesses were extended by the American Taxpayer Relief Act of 2012 (ATRA). The bad news: Many of these breaks were extended only through 2013 - though they may be revived for 2014. Also, if you own the business, it’s likely your biggest investment, so thinking about long-term considerations, such as your exit strategy, is critical as well. And if you’re an executive, you likely have to think about not only the company’s taxes, but also tax considerations related to compensation you receive beyond salary and bonuses, such as stock options. Planning for executive comp gets even more complicated this year, because of the potential impact of higher tax rates and expanded Medicare taxes. Projecting income Projecting your business’s income for this year and next will allow you to time income and deductions to your advantage. It’s generally — but not always — better to defer tax, so consider: Deferring income to next year. If your business uses the cash method of accounting, you can defer billing for your products or services. Or, if you use the accrual method, you can delay shipping products or delivering services. But don’t let tax considerations get in the way of making sound business decisions. Accelerating deductions into the current year. This also will defer tax. If you’re a cash-basis taxpayer, you may want to make an estimated state tax payment before Dec. 31, so you can deduct it this year rather than next. But consider the alternative minimum tax (AMT) consequences first. Both cash- and accrual-basis taxpayers can charge expenses on a credit card and deduct them in the year charged, regardless of when the credit card bill is paid. Warning: Think twice about these strategies if you’re experiencing a low-income year. Their negative impact on your cash flow may not be worth the potential tax benefit. Taking the opposite approach. If it’s likely you’ll be in a higher tax bracket next year, accelerating income and deferring deductible expenses may save you more tax. Depreciation For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years. In most cases the Modified Accelerated Cost Recovery System (MACRS) will be preferable to the straight-line method because you’ll get a larger deduction in the early years of an asset’s life. But if you make more than 40% of the year’s asset purchases in the last quarter, you could be subject to the typically less favorable midquarter convention. Careful planning during the year can help you maximize depreciation deductions in the year of purchase. Other depreciation-related breaks and strategies also are available: 50% bonus depreciation. ATRA extended this additional first-year depreciation allowance generally only to qualifying assets acquired and placed in service in 2013 (2014 for certain long-lived and transportation property). Qualified assets include new tangible property with a recovery period of 20 years or less (such as office furniture, equipment and company-owned vehicles), off-the-shelf computer software, water utility property and qualified leasehold-improvement property. Corporations can accelerate certain credits in lieu of claiming bonus depreciation for qualified assets acquired and placed in service through Dec. 31, 2013. (For certain long-lived and transportation property, the deadline is Dec. 31, 2014.) Check back here to learn if Congress extends 50% bonus depreciation to 2014 or beyond. Section 179 expensing election.This break provides another way to deduct (rather than depreciate) more of your asset purchase costs. But unless Congress revives enhanced Sec. 179 expensing, this break won't be as valuable in 2014. Accelerated depreciation. ATRA revived only through 2013 the break allowing a shortened recovery period of 15 years — rather than 39 years — for qualified leasehold-improvement, restaurant and retail-improvement property. Check back here to learn if Congress extends accelerated depreciation to 2014 or beyond. Cost segregation study. If you’ve recently purchased or built a building or are remodeling existing space, consider a cost segregation study. It identifies property components and related costs that can be depreciated much faster and dramatically increase your current deductions. Typical assets that qualify include decorative fixtures, security equipment, parking lots, landscaping and architectural fees allocated to qualifying property. The benefit of a cost segregation study may be limited in certain circumstances — for example, if the business is subject to the AMT or located in a state that doesn’t follow federal depreciation rules. (For information on some changed breaks for owners of leasehold, restaurant or retail properties, see “Depreciation-related breaks expired Dec. 31, 2013.") Vehicle-related tax breaks Business-related vehicle expenses can be deducted using the mileage-rate method (56.0 cents per mile driven in 2014) or the actual-cost method (total out-of-pocket expenses for fuel, insurance and repairs, plus depreciation). Purchases of new or used vehicles may be eligible for Sec. 179 expensing, and purchases of new vehicles may be eligible for bonus depreciation. However, many rules and limits apply. For example, the normal Sec. 179 expensing limit generally applies to vehicles weighing more than 14,000 pounds, but the limit is only $25,000 for SUVs weighing more than 6,000 pounds but no more than 14,000 pounds. Vehicles weighing 6,000 pounds or less don’t satisfy the SUV definition and thus are subject to the passenger automobile limits. For autos placed in service in 2014, the depreciation limit is $3,160. The amount that may be deducted under the combination of MACRS depreciation, Sec. 179 and bonus depreciation rules for the first year is limited under the luxury auto rules. In addition, if a vehicle is used for business and personal purposes, the associated expenses, including depreciation, must be allocated between deductible business use and nondeductible personal use. The depreciation limit is reduced if the business use is less than 100%. If business use is 50% or less, you can’t use Sec. 179 expensing, bonus depreciation or the accelerated regular MACRS; you must use the straightline method. Manufacturers’ deduction The manufacturers’ deduction, also called the “Section 199” or “Domestic Production Activities Deduction,” is 9% of the lesser of qualified production activities income or taxable income. The deduction is also limited to 50% of W-2 wages paid by the taxpayer that are allocable to domestic production gross receipts. The deduction is available to traditional manufacturers and to businesses engaged in activities such as construction, engineering, architecture, computer software production and agricultural processing. It isn’t allowed in determining net earnings from self-employment and generally can’t reduce net income below zero to create a net operating loss (NOL). But it can be used against the AMT. Employee benefits Including a variety of benefits in your compensation package can help you not only attract and retain the best employees, but also manage your tax liability: Qualified deferred compensation plans. These include pension, profit-sharing, SEP and 401(k) plans, as well as SIMPLEs. You can enjoy a tax deduction for your contributions to employees’ accounts, and the plans offer tax-deferred savings benefits for employees. Certain small employers may also be eligible for a credit when setting up a plan. (For more on the benefits to employees, see “401(k)s and other employer plans.”) HSAs and FSAs. If you provide employees with qualified high-deductible health insurance, you can also offer them Health Savings Accounts. Regardless of the type of health insurance you provide, you also can offer Flexible Spending Accounts (FSA) for health care. If you have employees who incur day care expenses, consider offering FSAs for child and dependent care. Fringe benefits. Some fringe benefits, such as group term-life insurance (up to $50,000), health insurance, parking (up to $250 per month for 2014), mass transit / van pooling (up to $130 per month for 2014 — unless Congress extends transit benefit parity again) and employee discounts, aren’t included in employee income. Yet the employer still receives a deduction for the portion, if any, of the benefit it pays and typically avoids payroll tax as well. Certain small businesses providing health care coverage to their employees may be eligible for a tax credit. Warning: Beginning in 2015, if you’re considered a large employer and don’t offer full-time employees sufficient health care coverage, you could be at risk for penalties under the health care act. The IRS issued final regulations in February 2014 that provide "transitional relief" for 2015 intended to help give affected employers sufficient time to comply, and more guidance is expected. Contact your tax advisor for the latest information. NQDC. Nonqualified deferred compensation plans generally aren’t subject to nondiscrimination rules, so they can be used to provide substantial benefits to executives and other key employees. But the employer generally doesn’t get a deduction for NQDC plan contributions until the employee recognizes the income. A net operating loss occurs when operating expenses and other deductions for the year exceed revenues. Generally, an NOL may be carried back two years to generate a refund. Any loss not absorbed is carried forward up to 20 years. Carrying back an NOL may provide a needed influx of cash. But you can elect to forgo the carryback if carrying the entire loss forward may be more beneficial, such as if you expect your income to increase substantially or tax rates to go up. Tax credits Tax credits reduce tax liability dollar-for-dollar, making them particularly valuable. Here are a few credits to consider: Work Opportunity credit. This credit, designed to encourage hiring from certain disadvantaged groups, had expired Dec. 31, 2011, for most groups, and an expanded credit for qualifying veterans had expired Dec. 31, 2012. ATRA has extended the credit for most eligible groups through 2013. Examples of qualifying groups included food stamp recipients, ex-felons and non-disabled veterans who’d been unemployed for four weeks or more, but less than six months. For hiring from these groups, the credit generally equaled 40% of the first $6,000 of wages paid, for a maximum credit of $2,400 per qualifying employee. A larger credit of up to $4,800 was available for hiring disabled veterans. And, if you hired veterans who’d been unemployed for six months or more in the preceding year, the maximum credits was even greater: $5,600 for nondisabled veterans and $9,600 for disabled veterans. Check back here to learn if Congress extends the Work Opportunity credit to 2014 or beyond. Health care coverage credit for small businesses. For tax years 2010 to 2013, the maximum credit was 35% of group health coverage premiums paid by the employer. For 2014 and beyond, the maximum credit increases to 50%, but coverage generally must be purchased through the Small Business Health Options Program (SHOP) and the credit can be taken for only two years, which must be consecutive. To get the credit, you must contribute at least 50% of the total premium or of a benchmark premium. The full credit is available for employers with 10 or fewer full-time equivalent employees (FTEs) and average annual wages of $25,000 or less per employee. Partial credits are available on a sliding scale to businesses with fewer than 25 FTEs and average annual wages of less than $50,000. Retirement plan credit. Small employers (generally those with 100 or fewer employees) that create a retirement plan may be eligible for a $500 credit per year for three years. The credit is limited to 50% of qualified startup costs. Research credit. The credit expired Dec. 31, 2013, and was equal to a portion of qualified research expenses. (See “What’s new! Research credit expired Dec. 31, 2013.”) Other credits. Examples of other expired credits that expired Dec. 31, 2013, include various energy-related credits, the new markets credit and the empowerment zone credit. Congress may extend some or all of these credits; check back here for updates. Business structure Income taxation and owner liability are the main factors that differentiate one business structure from another. Many businesses choose entities that combine flow-through taxation with limited liability, namely limited liability companies (LLCs) and S corporations. After ATRA, the top individual rate is higher (39.6%) than the top corporate rate (generally 35%), which might affect business structure decisions. For tax or other reasons, a structure change may be beneficial in certain situations, but there may be unwelcome tax consequences, so be sure to consult your tax advisor. Some tax differences between structures may provide planning opportunities, such as those related to salary vs. distributions. (See “Employment taxes for owner-employees.”) Exit planning An exit strategy is a plan for passing on responsibility for running the company, transferring ownership and extracting your money from the business. This requires planning well in advance of the transition. Here are the most common exit options: Buy-sell agreements. When a business has more than one owner, a buy-sell agreement can be a powerful tool. The agreement controls what happens to the business when a specified event occurs, such as an owner’s retirement, disability or death. Among other benefits, a well-drafted agreement:
Allows business continuity by preventing disagreements caused by new, unwanted owners. A key issue with any buy-sell agreement is providing the buyer(s) with a means of funding the purchase. Life or disability insurance often helps fulfill this need and can give rise to several tax and nontax issues and opportunities. One of the biggest advantages of life insurance as a funding method is that proceeds generally are excluded from the beneficiary’s taxable income. There are exceptions, however, so be sure to consult your tax advisor. Succession within the family. You can pass your business on to family members by giving them interests, selling them interests or doing some of each. Be sure to consider your income needs, how family members will feel about your choice, and the gift and estate tax consequences. Now may be a particularly good time to transfer ownership interests through gifting. If your business has lost value, you can transfer a greater number of shares without exceeding your $14,000 gift tax annual exclusion amount. Valuation discounts may further reduce the taxable value. (See “Gift interests in your business.”) And, with the lifetime gift tax exemption at a record-high $5.34 million for 2014, this may be a great year to give away more than just your annual exclusion amounts. Management buyout. If family members aren’t interested in or capable of taking over your business, one option is a management buyout. This may provide for a smooth transition because there may be little learning curve for the new owners. Plus you avoid the time and expense of finding an outside buyer. ESOP. If you want rank and file employees to become owners as well, an employee stock ownership plan (ESOP) may be the ticket. An ESOP is a qualified retirement plan created primarily to purchase your company’s stock. Whether you’re planning for liquidity, looking for a tax-favored loan or wanting to supplement an employee benefit program, an ESOP can offer many advantages. Selling to an outsider. If you can find the right buyer, you may be able to sell the business at a premium. Putting your business into a sale-ready state can help you get the best price. This generally means transparent operations, assets in good working condition and minimal reliance on key people. Sale or acquisition Whether you’re selling your business as part of your exit strategy or acquiring another company to help grow it, the tax consequences can have a major impact on the transaction’s success or failure. Here are a few key tax considerations: Asset vs. stock sale. With a corporation, sellers typically prefer a stock sale for the capital gains treatment and to avoid double taxation. Buyers generally want an asset sale to maximize future depreciation write-offs. Taxable sale vs. tax-deferred transfer. A transfer of ownership of a corporation can be tax-deferred if made solely in exchange for stock or securities of the recipient corporation in a qualifying reorganization. But the transaction must comply with strict rules. Although it’s generally better to postpone tax, there are some advantages to a taxable sale:
The parties don’t have to meet the technical requirements of a tax-deferred transfer. Installment sale. A taxable sale may be structured as an installment sale, due to the buyer’s lack of sufficient cash or the seller’s desire to spread the gain over a number of years. Spreading out the gain may be especially desirable now because it may allow you to stay below thresholds that would trigger additional tax. (See “Top capital gains rates have increased” and “Will you owe the 3.8% Medicare tax on investment income?”) Installment sales are also useful when the buyer pays a contingent amount based on the business’s performance. But an installment sale can backfire on the seller. For example, depreciation recapture must be reported as gain in the year of sale, no matter how much cash the seller receives. And, if tax rates increase, the overall tax could wind up being more. Of course, tax consequences are only one of many important considerations when planning a merger or acquisition. Incentive stock options If you’re an executive with a larger company, you may receive incentive stock options (ISOs). ISOs receive tax-favored treatment but must comply with many rules. ISOs allow you to buy company stock in the future (but before a set expiration date) at a fixed price equal to or greater than the stock’s fair market value (FMV) at the date of the grant. Therefore, ISOs don’t provide a benefit until the stock appreciates in value. If it does, you can buy shares at a price below what they’re then trading for, as long as you’ve satisfied the applicable ISO holding periods. Here are the key tax consequences:
If you’ve received ISOs, plan carefully when to exercise them and whether to immediately sell shares received from an exercise or hold them. Waiting to exercise ISOs until just before the expiration date (when the stock value may be the highest, assuming the stock is appreciating) and holding on to the stock long enough to garner long-term capital gains treatment often is beneficial. But there’s also market risk to consider.
On the negative side, exercising early accelerates the need for funds to buy the stock, exposes you to a loss if the shares’ value drops below your exercise cost, and may create a tax cost if the preference item from the exercise generates an AMT liability. The timing of ISO exercises could also positively or negatively affect your liability for the 39.6% ordinary income tax rate, the 20% long-term capital gains rate or the expanded Medicare taxes (see “You could owe expanded Medicare taxes on your exec comp”). With your tax advisor, evaluate the risks and crunch the numbers using various assumptions to determine the best strategy for you. Nonqualified stock options The tax treatment of nonqualified stock options (NQSOs) is different from that of ISOs: NQSOs create compensation income (taxed at ordinary-income rates) on the bargain element when exercised (regardless of whether the stock is held or sold immediately), but they don’t create an AMT preference item. You may need to make estimated tax payments or increase withholding to fully cover the tax on the exercise. Keep in mind that an exercise could trigger or increase exposure to top ordinary income tax rate and top capital gains tax rate and expanded Medicare taxes. (see “You could owe expanded Medicare taxes on your exec comp”). Restricted stock and RSUs Restricted stock is stock that’s granted subject to a substantial risk of forfeiture. Income recognition is normally deferred until the stock is no longer subject to that risk or you sell it. You then pay taxes based on the stock’s fair market value when the restriction lapses and at your ordinary-income rate. But, under Section 83(b), you can elect to instead recognize ordinary income when you receive the stock. This election, which you must make within 30 days after receiving the stock, can be beneficial if the income at the grant date is negligible or the stock is likely to appreciate significantly before income would otherwise be recognized. Why? Because the election allows you to convert future appreciation from ordinary income to long-term capital gains income and defer it until the stock is sold. There are some disadvantages of a Sec. 83(b) election: First, you must prepay tax in the current year — and you could trigger or increase your exposure to the 39.6% ordinary-income tax rate or the additional 0.9% Medicare tax. But if a company is in the earlier stages of development, the income recognized may be small. Second, any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or you sell it at a decreased value. But you’d have a capital loss when you forfeited or sold the stock. Work with your tax advisor to map out whether the Sec. 83(b) election is appropriate for you in each particular situation. If you've been awarded restricted stock units (RSUs), however, the Sec. 83(b) election won't be available. But RSUs still providing tax planning opportunities. NQDC plans Nonqualified deferred compensation plans pay executives in the future for services to be currently performed. They differ from qualified plans, such as 401(k)s, in several ways. For example, unlike 401(k) plans, NQDC plans can favor highly compensated employees, but any NQDC plan funding isn’t protected from the employer’s creditors. One important NQDC tax issue is that employment taxes are generally due once services have been performed and there’s no longer a substantial risk of forfeiture — even though compensation may not be paid or recognized for income tax purposes until much later. So your employer may withhold your portion of the payroll taxes from your salary or ask you to write a check for the liability. Or it may pay your portion, in which case you’ll have additional taxable income. Keep in mind that the rules for NQDC plans are tighter than they once were, and the penalties for noncompliance can be severe: You could be taxed on plan benefits at the time of vesting, and a 20% penalty and potential interest charges also could apply. So check with your employer to make sure it’s addressing any compliance issues. • |
